Discussion Paper

No. 2009-31 | July 08, 2009
Exchange-Rate Regime and Economic Growth: A Review of the Theoretical and Empirical Literature
(Submitted for Survey and Overview)

Abstract

The aim of this paper is to examine the theoretical and empirical arguments for the relationship between the exchange-rate regime and economic growth. As a nominal variable, the exchange rate (regime) might not affect the long-run economic growth. However, there is no unambiguous theoretical evidence what impacts the exchange-rate target exhibits on growth. The channel through which the regime might influence growth is trade, investment and productivity. Theoretical considerations relate the exchange-rate effect on growth to the level of uncertainty imposed by flexible option of the rate. However, while reduced policy uncertainty under a peg promotes an environment which is conductive to production factor growth, trade and hence to output, such targets do not provide an adjustment mechanism in times of shocks, thus stimulating protectionist behaviour, price distortion signals and therefore misallocation of resources in the economy. Consequently, the relationship remains blurred and requires in-depth empirical investigation.
The empirical research offers divergent result though. A big part of the studies focuses on the parameter of the exchange-rate dummy, but does not appropriately control for other country-characteristics nor apply appropriate growth framework. Also, the issue of endogeneity is not treated at all or inappropriate instruments are repeatedly used. Very few studies disgracedly pay small attention to the capital controls, an issue closely related to the exchange-rate regime and only one study puts the issue in the context of monetary regimes. Overall, the empirical evidence is condemned because of growth-framework, endogeneity, sample-selection bias and the so-called peso problem. An empirical investigation which will consider all those aspects might reveal clear and robust suggestion of the relationship between exchange-rate regime and growth.

JEL Classification

E42 F31

Cite As

Marjan Petreski (2009). Exchange-Rate Regime and Economic Growth: A Review of the Theoretical and Empirical Literature. Economics Discussion Papers, No 2009-31, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2009-31

Assessment



Comments and Questions


Anonymous - Very useful survey
July 13, 2009 - 00:31

This is a well-written and very useful survey which I would have enjoyed reading a long time ago. I would like to make a few comments:
1) Many of the cited papers are from working paper series. Their selection is not made very clear- Are these the most important ones? ...[more]

... 2) The reference list needs to be updated. I was looking for "Dubas et al. (2005)", which is cited on page 6, but does not show up on page 15.
3) Finally, I would suggest the following papers, which might be worth including,
Jordi Gali and Tommaso Monacelli. Monetary policy and exchange rate volatility in a small open economy. Review of Economic Studies, 72(3):707-734, 2005.
Dani Rodrik. The real exchange rate and economic growth. Brookings Papers on Economic Activity, Fall 2008.
as well as the book
Atish R. Ghosh, Anne-Marie Gulde, and Holger C. Wolf. Exchange rate regimes: choices and consequences. MIT Press, 2002.


Marjan Petreski - Thanks
July 17, 2009 - 13:51

Thanks for the valuable comment. I know it is a bit older discussion, but I build on it my analysis of the switch from exchange-rate targeting to inflation targeting, and hence I needed to build the background.


Anonymous - Referee Report 1
August 18, 2009 - 08:49

See attached file


Michael Klein - Decision Letter
September 29, 2009 - 16:21

This paper is a survey of the literature on the theory and empirics of the link between the exchange rate regime and economic growth. It lists a number of papers that focus on this issue. The paper would benefit from an effort to better synthesize this literature, and show the ...[more]

... linkages and associations across papers. Failing to do this, and without the prospect of a revision, I am rejecting this paper.